Struggles over public policy take place on two levels – the day-to-day conflict over specific policies (should tax cuts be extended and for whom, whether we should balance the budget or stimulate) and the larger, often somewhat subterranean debates over the political economy of the country.

Behind debates (largely within the Democratic Party, given the Republican Party’s commitment to universal obstruction) over whether to “stimulate now, and cut later” or “cut now and cut later” is a division over what kind of economic order we want to have. The Stimulus Caucus broadly supports an economic order marked by more attention to unemployment levels, economic growth, and investments in infrastructure and human capital. The Pain Brigade by contrast supports an economic order marked by more attention to the profits of the financial sector, and maintaining weak regulations and low taxes on financial corporations, financial executives, and stockholders, and which is more comfortable with high levels of unemployment – as long as it means low inflation and low interest rates.

However, as much as I side with the Stimulus Caucus, I feel compelled to point out that their basic model of “stimulate now, cut later” is marked with a serious flaw: stimulating back to the pre-crash economy isn’t good enough, because the pre-crash economy has serious long-term problems that require permanent solutions.

American Labor Market – Now and Then:

The most recent unemployment report confirms that our Great Recession has begun a new and quite ominous phase: for the last four months, private employers have been hiring at a sluggish rate of about 60-70,000 jobs a month (about half what is needed to match the increase in the labor force), but the rise in private employment has been surpassed by a decline in public sector employment. Initially the result of post-Census layoffs, we are beginning to see more and more the effects of fiscal retrenchment at the state and local level.

Hat tip to Ezra Klein

Welcome to the anti-stimulus. Although they’d never admit it, what we have right now is the conservative prescription for economic policy enacted in virtually every state house across the country – state governments, lacking the counter-cyclical capacity to undertake Keynesian stimulus or the political will to raise taxes in a recession, have cut spending, furloughed workers, and cut pensions and pay. And the results could not be clearer – private sector employment, which had been growing at an increasing clip earlier this year as public sector work forces expanded thanks to the stimulus and the Census, has cut back largely due to fears of declining demand.

In other words, in the last eight months we have experienced 1937 in miniature. As I have discussed before, the New Deal’s track record of lowering unemployment has been grossly overlooked. From 1933 to 1937, unemployment dropped from about 25% to 9.1%, the most successful recovery attempt in the 20th century; this was largely achieved by the government hiring over three and a half million workers to work for the WPA. As on the chart above for January through March, as the public sector payroll surged, private employers responded by expanding their production and their payroll to meet increased demand. In 1937, however, FDR unwisely attempted to balance the budget, largely by cutting back on WPA spending, and brought on a recession. While Obama didn’t actually reverse himself, the lack of a second stimulus, combined with the effects of 50 Hoovers has had the same effect.

Never has the case for direct job creation been clearer: the private sector is gradually expanding, but needs an expanding public sector to provide the foundation for consumer demand; far from producing business confidence, public sector cutbacks have sapped the recovery of its vigor.

However, I would part with those like Krugman and DeLong who call for stimulus now and deficit reduction later by arguing that we actually need direct job creation after the recession is over, in order to keep it from happening again. I firmly believe that one of the major reasons why the recession happened and why it has been so unusually severe in terms of job loss compared to the actual decrease in consumption or production is due to a longer-term structural shift away from wages and labor costs and toward profits and capital that is leading to persistent weakness in labor demand, especially for jobs that pay a living wage.

In addition to increasingly jobless recoveries, recent years have shown a surprisingly soft labor market, to the extent that in the recovery from the last recession, the labor force participation rate actually declined and then flatlined, as we can see above. We can also see this softness in the fact that the broader U6 measure of unemployment has been stubbornly high. Even during the white-hot labor market of 2000, when U3 fell to 4% and we actually started to see some wage growth for the first time in a long time, the U6 rate never fell below 6.8%. U6 stayed quite high throughout most of the early recovery, and stayed above 8% at the best of the most recent recovery.

This slackness in the labor market, among other factors, has caused wage growth to flat-line, since workers are less likely to push for wage hikes when they know that they can be easily replaced, either by one of the unemployed, through increase in productivity, or through mechanization or offshoring, especially when the unions that normally foster wage growth are in decline. When wages stagnate, wage-based consumption can’t grow fast enough to keep up with increasing production. Over the last decade, this was papered over with an artificially abundant supply of credit, making our economy more vulnerable to sudden credit crunches than it has been in the past. Hence, when a financial crisis paralyzes the credit supply, consumption drops faster than it would if consumption was more solidly based on wages; in turn, employers react to sharper declines in consumption with sharper increases in layoffs, creating a downwards spiral.

In other words, what we need is a sustained period of unusually low unemployment – at the very least matching the U6 rates experienced in 2000 – if we want to accomplish multiple economic goals. Sustained low unemployment is of course a goal on its own, but it also means higher GDP growth from the extra production created by otherwise idle workers, higher consumption, and a true economic recovery.

Putting It All Together:

The problem with “targeted, temporary” solutions is two-fold. Temporary solutions – like another round of stimulus – means that we don’t develop institutional capacity that will be in place to either prevent or better cushion the next recession; which means that in the next recession, we will have to reinvent the wheel as we did with the American Recovery and Reinvestment Act, and it means that we don’t have anything in place to help us “stick the landing” just as what happened in 1937 when FDR tried to put the economy through a cold-turkey withdrawal. Targeted solutions create zero sum politics that enable conservatives to turn the suffering employed (who are dealing with hour and wage cutbacks, retirement and housing losses, and the like) against the suffering unemployed; it runs the risk of creating traps for people who want to get back on their feet; and it means that we don’t help everyone who’s in need when we end up defining need in a narrow sense.

By contrast, a permanent system of Job Insurance creates an institutional capacity for dealing with unemployment and recessions that can be relied upon for generations. The Swedish beredskeparbete system successfully kept unemployment at 2.5% or below for a period of nearly 60 years; a Job Insurance program would have the same potential for self-sustaining support that Social Security or Medicare have. Similarly, Job Insurance would allow us to deal with both the immediate need to drop unemployment and get the recovery moving and the longer-term problem of anemic job markets – ensuring not merely an end to the Great Recession but a permanently lower average unemployment rate and a milder business cycle, a la the German system. Finally, Job Insurance creates a positive sum politics whereby people with jobs gain security for the future and people without can contribute to recovery.

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The Realignment Project is a group blog dedicated to the discussion of current political events, political strategy, ideology, and history. Co-Founders: Steven Attewell is a PhD student in the history of public policy at UC Santa Barbara, studying the history of direct job creation programs from the New Deal to ... Continue reading →